VIX Update: Volatility Returns to Status Quo

by Tyler Craig | March 13, 2012 9:30 am

VIX Update: Volatility Returns to Status Quo

The 1.4% market selloff last Tuesday caused quite the commotion in the options market. Concurrent with the downdraft, the CBOE Volatility Index (CBOE:VIX[1]) registered its largest one-day rise of 2012 as it surged 15%. The question plaguing worried investors as to whether or not the surge in fear was an ominous sign or much ado about nothing has been largely answered over the past few trading sessions. This 15% gain quickly unraveled and the VIX returned to its recent status quo.

Traders should remember that a bet on the VIX is a de-facto bet on the direction of the S&P 500 Index. The only way a VIX spike will keep on spiking is if a market selloff keeps on selling. The fact that the market has bounced back so quickly from last Tuesday’s selloff should explain why the VIX spike turned into a one-day wonder.

The current volatility landscape is quite similar to its status before the market selloff, albeit with a few minor changes. Realized market volatility, as measured by 21-day historical volatility (HV), has ticked up from 8% to 10%. The VIX has actually dropped from last Monday’s close from 18% to 16%. The simultaneous rise in HV and fall in implied volatility (the VIX) has brought option prices more in-line with historical norms.

Traders’ outlook on the VIX going forward should be largely dependent on their outlook for the S&P 500 Index itself. Those looking for a continuation in the current uptrend should look for a flat-to-lower VIX in the coming weeks. Until we see the underlying bid beneath the market deteriorate, I see little reason for making overly bearish prognostications on the overall market (and thus bullish bets on the VIX).

It’s also worth noting that in the post-2008 world, the VIX has been altogether unwilling to close beneath 15. This theoretical floor has halted any decline in the VIX for the past four-plus years. The fact that the VIX is so close to this level would also lead me to conclude that big bearish bets on the VIX index are probably unwise at current prices. Thus, despite my generally mildly bearish view for the VIX, I suggest waiting for some type of spike before initiating new bearish positions.

At the time of this writing, Tyler Craig owned bearish positions on a VIX-related ETN – VXX.